The Fed Saved the Day, But…

William Isaac, former chairman of the FDIC and now chairman of The Secura Group, says that the Fed’s actions averted disaster but raised serious questions.

I believe that too much is being made of the current problems in the financial and real estate markets. We have been told in headlines that we are in the midst of the worst banking crisis since the Great Depression. If there is a banking crisis, I have seen no evidence of it.

I can count on my fingers and toes every sizable bank about which I have had any concern during the past year. We suffered through more than 3,000 bank and thrift failures during the 1980s and early 1990s and still had 1,430 banks on the problem list at year-end 1991. I’m sure the problem bank list will grow during the next year, but it totaled only 76 at last count. Banks continue to have incredible access to the capital markets, and over 99% of all banks are considered “well capitalized” by the regulators.

When the headlines are not focused on the “banking crisis,” they are fixated on the dramatic decline in home prices—more than 20% from peak levels in some major markets. I’m not sure why we are upset about a 20%-off sale in housing.

While those who purchased homes in the past couple of years are unhappy if their investment is under water, the housing markets will be back for those who are able to hang on—with help from their lenders where appropriate. The good news is that we have a lot of housing stock at more affordable prices for our growing population.

This brings me back to the Fed. We had a major crisis of confidence in the financial markets, due in significant part to a loss of faith in the rating agencies and others, especially with respect to mortgage-backed securities. No one knew how big the problems were or even where they resided, so the mortgage securitization markets closed down, and financial firms stopped lending to each other.

The Fed displayed ingenuity and persistence on a variety of fronts in its efforts to help end the crisis in confidence. While some argue it waited too long, the Fed cut rates aggressively. And it developed and refined a unique auction process to put tens of billions of dollars of cash into the hands of the banks.

The rescue of Bear Stearns was a strong statement by the government that it would do everything in its power to restore sanity to the markets. Having been at the helm of the Federal Deposit Insurance Corporation (FDIC) when Continental Illinois was rescued in 1984, I can appreciate what the Fed did.

Now we are left with the aftermath. The transaction marks a vast expansion of the federal safety net (i.e., the Fed discount window and the FDIC fund), which has been paid for exclusively by highly regulated insured banks. Will investment banks now be required to support the safety net and be regulated like banks?

Bear Stearns also marks the first time the Fed has taken meaningful financial risk in facilitating a takeover. Do we want the Fed underwriting takeovers of failing firms without a competitive bidding process, which is routinely used when insured banks fail?

I’m delighted the liquidity crisis has eased, and I believe the Fed had a big hand in that. But I’m deeply troubled by the precedent that has been set and the implications for our financial system. It’s time for a good debate about the authority and role of our central bank.